Leverage Ratio Delegated Act

The Capital Requirements Regulation (CRR) was introduced on 1.1.2014 with a view to limiting the future indebtedness of institutions in relation to their capital with, among other things, regulations governing the debt ratio (LR = Leverage Ratio). Under the Pillar II framework, the LR has had to be calculated and reported since 2014 already, however, the disclosure requirement (Pillar III) has only been in force since 01.01.2015. The migration of the requirements to Pillar I, as an additional standard for restricting capital, is planned for 01.01.2018.

Article 456(1)(j) of the CRR basically empowered the Commission to amend the numerator and denominator of the leverage ratio, thus the capital measure and the total exposure measure, before the 01.01.2015 - when mandatory disclosure begins - through a delegated act if it uncovers shortcomings.

In this connection, the European Banking Authority (EBA) informed the Commission that there are significant differences in how institutions understand and interpret the existing rules.

In order to avoid differences in the way the LR is calculated - arising from these various interpretations - and to ensure that, in the future, the numbers that have to be disclosed would be comparable, on 10.10.2014, the Commission published a final draft of a "Delegated Act", which clarifies Article 429 of the CRR. In the course of this, Article 429 was restructured and supplemented by 2 further Articles (429a and 429b). Implementation was through the Commission Delegated Regulation (EU) 2015/62. This was published in the Official Journal of the EU on 17.01.2015 and came into effect on 18.01.2015.

The new rules, first of all, serve to simplify the calculation mechanism and the scope of consolidation. In future, the LR shall be calculated purely as a quarterly value at the end of the quarter and the pro rata "inclusion" of material investments in entities in the financial sector, which are consolidated in accordance with accounting rules but not regulatory rules, will no longer be required.

IRB institutions are explicitly allowed to deduct an existing provisioning shortfall from the total exposure measure and there are basic simplification options in the case of "recognised" intra group exposures and special exposures to public sector entities. If certain conditions are fulfilled, national supervisors may allow institutions to exclude these exposures from the denominator of the LR each time when calculating the total exposure measure.

There will be significant changes in the case of repo, lending and similar transactions. It is clear from the context of the regulation that these transactions have been essentially allocated to the asset category and it is no longer possible to use the Financial Collateral Comprehensive Method when calculating the exposure measure. Notwithstanding this fundamental prohibition on offsetting, provided that certain strict conditions are satisfied, cash receivables and payables from repo, lending and similar transactions that exist with the same counterparty may be considered on a net basis and, thus, taken into account in the total exposure measure after netting.

A new feature has been introduced for repo, lending and similar transactions - an add-on for counterparty credit risk, which will have to be additionally taken into consideration in an institution’s total exposure measure (new Article 429 b in the CRR). In principle, this is the equivalent to the difference in value (which may not be negative) between the fair value of securities or cash lent and the fair value of securities or cash received.

In order to exclude the possibility of these not being taken into account in the total exposure measure, the Delegated Act stipulates that where sale accounting is achieved for a repurchase transaction under its applicable accounting framework then this has to be "recouped", i.e. the sales-related accounting entries have to be reversed accordingly. Furthermore, for institutions that act as agents, a new feature is the taking into account of repo, lending and similar transactions in the total exposure measure on a graduated basis and depends on the extent of the liability that has been assumed.

As part of the fundamental restructuring of Article 429 of the CRR, the LR rules relating to derivatives and credit derivatives have been assigned to the newly introduced Article 429a of the CRR. There are also significant changes within the scope of these transactions. Under certain circumstances, when calculating the exposure value, the use of cross-product netting is now permitted. If the provision of collateral in connection with derivatives has reduced the value of assets under the applicable accounting framework then this effect will have to be "reversed", i.e the total exposure measure will have to be increased accordingly. As the cash variation margin can be viewed as a form of premature close-out, when calculating the credit equivalent amount for a derivative, in each case under certain circumstances, a variation margin received in cash may be subtracted from the potential replacement cost and a capitalised cash variation margin that is provided may be deducted from the total exposure measure. For a written credit derivative, in the LR, an exposure value has to be determined for both the derivative itself as well as for the underlying reference asset, although, this reference asset should be included at its "effective notional amount" in the total exposure measure. In this case, under certain circumstances, the Delegated Act permits "adjustments" to be made to this effective notional amount (e.g. offsetting the effective notional amounts of purchased credit derivatives with the same reference name) as well as, in particular, adapting the add-on of the written credit derivative.

In the case of off-balance sheet transactions, in the new version of the regulation for the calculation of exposure value the notional amount is explicitly no longer reduced by specific credit risk adjustments and, moreover, instead of particular "LR CCFs" the CCFs for the standardised approach should be used, although a floor of 10% shall be applicable. Furthermore, the IRB rule of Article 166(9) of the CRR now applies; according to this, if a commitment refers to the extension of another commitment then the lower of the CCFs associated with the individual commitments shall be used.

In addition, the Delegated Act regulates, in particular, the treatment of trade exposures of financial intermediaries and of guarantees that an institution acting as a clearing member provides to a qualifying central counterparty on behalf of a customer. In the former case, under certain circumstances, a "deduction of the customer portion" is permitted and, in the latter case, it is a requirement to include the guarantee, in the total exposure measure, as a derivative exposure value to the customer.

On the basis of the Consultation Paper EBA/CP/2014/44 of 16.12.2014, on 15.06.2015, the EBA Final Draft ITS EBA/ITS/2015/03 was published. This is intended to adapt the current reporting requirements with regard to the Leverage Ratio that are laid down in Annexes X and XI of the "ITS on supervisory reporting" (Commission Implementing Regulation (EU) No 680/2014) of 16.04.2014). However, as the implementation by the Commission is still outstanding, currently, there are still no new formal and valid regulations for reporting the Leverage Ratio. Owing to the inconsistencies resulting from two valid and binding sets of EU Regulations (the "new" CRR vs. the "old" reporting templates), until the Implementing Technical Standard becomes legally valid "old legislation on old reporting templates" shall be applicable.

As the Implementing Technical Standard on Reporting will only come into force six months after its publication in the Official Journal of the European Union, from today's perspective, the 30.06.2016 would be the earliest possible date for for the first-time reporting of the LR in accordance with the new legislation. In the course of this, until the implementation of the new ITS, institutions will be free to choose between quarterly average and quarter end as the basis for calculating the LR.

List of sources

Draft of Commission Delegated Regulation with regard to the leverage ratio, of 10.10.2014, including a preceding statement setting out the grounds.

Commission Delegated Regulation (EU) 2015/62.

Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 in the amended version of 30.11.2013.

Robert Scheurell has been involved in projects within the banking regulatory and regulatory reporting domain since 1998 – both as a member and manager of project teams. His expertise covers the whole range of bank-statistical reporting and includes detailed knowledge of standard reporting software like SAMBAplus or ABACUS/DaVinci. Within SKS, Robert Scheurell is responsible for the SKS software product iCALC.